The dollar plummets after the Fed policy meeting

Important calendar events

• EUR: German Trade Balance, French Government Budget Balance, Spanish Unemployment Change, Main Refinancing Rate, Monetary Policy Statement, ECB Press Conference
• GBP: BOE Monetary Policy Report, MPC Official Bank Rate Votes, Monetary Policy Summary, Official Bank Rate
• USD: Unemployment Claims, Challenger Job Cuts, Preliminary Nonfarm Productivity, Preliminary Unit Labour Costs

USD

The dollar dipped on Wednesday ahead of the Fed policy meeting, with the dollar index dropping to 101.7. US Treasury yields also retreated ahead of the meeting on reduced rate hike expectations, with the US 10-year bond yielding approximately 3.47%. After the conclusion of the meeting, the dollar plummeted, with the dollar index touching 101.1. US Treasury yields declined further, with the US 10-year bond yielding below 3.40%

Important economic activity and health indicators were released on Wednesday for the US, affecting dollar prices ahead of the Fed policy meeting. ADP Non-Farm Employment Change dropped drastically in January, indicating a contraction in the number of employed people. January’s print came at 106K against expectations of 176K and a much higher 253K print in December. JOLTS Job Openings for December on the other hand exceeded expectations, rising to 11.01M from 10.44M in November. ISM manufacturing PMI in January dropped surprisingly to 47.4 in January from 48.4 in December, indicating that the US manufacturing industry is contracting at an increased pace.

Fed interest rate changes have been the main factor driving the US dollar and treasury yields over the past few months. After a series of aggressive rate hikes last year, the Fed has finally decided to relax its hawkish policy. The Federal Reserve raised interest rates by only 25 basis points in Wednesday’s meeting, bringing the benchmark interest rate to a target range of 4.50% to 4.75%. A pivot towards a more dovish policy was expected by markets, however, and had been largely priced in. Nevertheless, the initial market response was negative for the dollar, and the currency plummeted.

Fed Chair Jerome Powell, at his press conference after the conclusion of the meeting defended the central bank’s decision to relax its hawkish policy. Powell expressed himself as satisfied with the ‘disinflation’ process. Powell emphasized, however, that ongoing rate hikes are appropriate since substantial evidence is necessary that inflation is under control.

Many analysts believe that the Fed will continue raising interest rates at a slower pace until the benchmark interest rate reaches at least 5.0%. This means that there are likely still a couple of rate hikes up ahead, which may provide support for the dollar. 

US inflation seems to be cooling, as US headline inflation also dropped to 6.5% year-on-year in December from 7.1% in November. Cooling price pressures have given the US Federal Reserve some leeway towards scaling back its interest rate increases, putting pressure on the dollar. 

Advanced quarterly GDP data revealed that the US economy is expanding at a higher rate than anticipated. US GDP for Q4 of 2022 grew by 2.9% against expectations of a 2.6% growth. The US is likely headed for an economic ‘soft landing’ and recession concerns ease. 

Several economic activities and health indicators are scheduled to be released on Thursday for the US including, Unemployment Claims, Challenger Job Cuts, Preliminary Nonfarm Productivity, Preliminary Unit Labour Costs and may affect the dollar in the wake of Wednesday’s Fed rate decision. 

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EUR 

The Euro gained strength against the dollar on Tuesday, with EUR/USD pushing past the 1.089 level resistance, and touching 1.100. If the currency pair goes up, it may encounter resistance near 1.118. If the EUR/USD pair declines, it may find support at 1.076. 

This week all eyes are going to be on the ECB monetary policy meeting on Thursday. Coming a day after the Fed policy meeting, the outcome of the ECB meeting will likely determine the trend of EUR/USD. Markets are pricing in another ECB 50-bp rate this week. On the other hand, the Fed has started to pivot towards a more dovish policy, voting for a 25-bp rate hike on Wednesday, boosting the Euro. 

Eurozone Final Manufacturing PMI remained steady at 48.8 in January, in line with expectations. The indicator is still below the threshold of 50, indicating that the manufacturing industry remains in contraction territory. EU unemployment levels are also high, remaining at print in December, against expectations of a 6.5% print.

Eurozone headline inflation dropped sharply in January according to CPI data released on Wednesday. Final EU headline inflation dropped to 8.5% year-on-year in January from a 9.2% print in December, indicating that Eurozone inflation is cooling. The continued drop in inflation signals that the ECB’s efforts to tame inflation are bearing fruit. 

Reduced fuel costs are one of the main reasons for the sudden drop in inflation. Core CPI, which excludes food and energy, remained steady in January at 5.2% on an annual basis. Price pressures in the Eurozone remain high though, and interest rates need to rise significantly to combat entrenched inflation. 

EU inflation rates are still far from the ECB’s 2% goal and are forcing the central bank to hike rates aggressively. In its monetary policy meeting in December, the ECB raised interest rates by 50 bp, bringing its benchmark interest rate to 2.50%. The question, however, is whether economic conditions in the Eurozone will allow the ECB to continue raising interest rates at a fast pace. EU economic outlook is poor, and the ECB might be forced to raise interest rates in a recessionary backdrop.

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GBP 

The Sterling gained strength against the dollar on Wednesday and GBP/USD skyrocketed to 1.239. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while support may be found near 1.226. 

The BOE monetary policy meeting will take place on Thursday and in conjunction with Wednesday’s Fed meeting, it is likely to affect the GBP/USD rate considerably. Markets are pricing in another 50-bp rate hike this week, but traders will also focus on the forward guidance given by the BOE. The Fed, on the other hand, proved to be less aggressive in its tightening regime on Wednesday, voting for a 25-bp increase, which boosted the Sterling against the dollar.

At the latest monetary policy meeting in December, BOE members voted to hike rates by 50 bps bringing its interest rate to 3.50%. With inflation remaining above 10%, this was perceived by many analysts as the start of a pivot towards a more dovish fiscal policy. 

The UK’s grim economic outlook is putting pressure on the Sterling. The IMF downgraded the UK’s growth forecast, predicting that the British economy will contract by 0.6% this year. Nationwide HPI released on Wednesday for the UK fell short of expectations, decreasing by 0.6% in January against estimates of a 0.5% drop. This is an indicator of housing inflation and also reflects economic conditions, showing that the housing industry’s health is declining. Final Manufacturing PMI rose to 47.0 in January from 46.7 in December, indicating a slight improvement in the manufacturing industry, but remaining below the 50 level which denotes industry expansion. 

The UK’s grim economic outlook may limit policymakers’ ability to increase interest rates sufficiently to rein in inflation. The final GDP print for the third quarter of 2022 was -0.3%, indicating that the economy in the UK is shrinking. The British economy is still struggling, and policymakers will have to assess how much tightening it can withstand to bring inflation down. 

Inflation data have shown that inflation in the UK is cooling. PPI data were released for two months, November and December. PPI Input dropped by 0.2% in November from an increase of 0.9% in October, and in December, consumer inflation cooled even further, decreasing by 1.1%. Similarly, PPI output data released for November and December showed that British manufacturers unexpectedly lowered their prices over the past two months. PPI Output printed at -0.1% in November from 0.9% in October and at -1.1% in December, suggesting that inflation may be easing. In addition, UK headline inflation dropped to 10.5% in December from 10.7% in November. 

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JPY

The Yen gained strength against the dollar after the Fed meeting on Wednesday, with USD/JPY dropping below the 128.7 level. If the USD/JPY pair declines, it may find support near 127.2 and further down at 114.2. If the pair climbs, it may find resistance at 131.6.

The final manufacturing PMI for Japan remained steady at 48.9 in January, in line with expectations. The index is still below the threshold of 50, indicating a contraction in the manufacturing industry.

Japanese policymakers maintained ultra-low interest rates at the BOJ’s January meeting, keeping the central bank’s refinancing rate at -0.10% as expected. BOJ Governor Haruhiko Kuroda defended the central bank's decision to keep its yield curve control policy unchanged and vowed to conduct unlimited bond buying to maintain the bank’s yield curve control. Kuroda, however, is due to retire in April and his successor may decide to unwind the BOJ’s ultra-easy policy. A pivot in Japan’s monetary policy within 2023, would boost the Yen considerably. 

The BOJ caused a stir in markets in its previous meeting in December by changing its yield control target for the 10-year government bond to between plus or minus 0.50%, from a previous 0.25%. The BOJ had set a target range around zero for government bond yields for years, and this adjustment may be the signal of a shift towards a more hawkish policy. Long-term, this move may allow interest rates to rise, cutting off some of its monetary stimuli.

BOJ Core CPI rose to 3.1% year-on-year, exceeding expectations of a 2.9% print. Inflation in Japan has gone above the BOJ’s 2% target, touching 40-year highs and putting pressure on businesses and households. National Core CPI for December was 4.0%, rising above November’s 3.7% print. 

The final GDP Price Index for the third quarter of 2022 showed economic contraction by 0.3% on an annual basis and the Japanese economy shrank by 0.2% in the third quarter of 2022, mainly due to the high costs of imported energy. Japan’s economic outlook is poor, raising recession concerns for the world’s third-biggest economy.

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Written by:
Myrsini Giannouli

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